Seeing Both Sides

Should I Become An Entrepreneur?

When to become an entrepreneur is a common quandary for many.  For whatever reason, this issue has come up a great deal recently (recession-driven workforce dislocation?), so I thought I'd share a few thoughts that might help frame this critical decision.

I have concluded that being an entrepreneur is an irrational state of being.  If human beings were purely rational, evaluative, value maximizing individuals (see HBS Prof Michael Jensen's paper on self-interest and human behavior), they would not start companies.  If they sat down and did the expected value calculation by laying out the probability-weighted outcomes of being an entrepreneur as compared to taking a safe job, it would not pencil out.  

Yet, entrepreneurship is not simply a rational journey.  It is one that is defined by passion and personal satisfaction that transcends purely financial analysis.  And, of course, there is always the hope for the big payout, no matter how long the odds.

Despite popular wisdom to the contrary, age is not a major factor in the decision to start a company.  The Kauffman Foundation reports that the median age of founders is 39 - right at the midpoint of a typical professional career - and 69% are 35 or older.   Another study by Washington University professors of 86,000 science and engineering graduates showed that age was not a significant predictor of becoming an entrepreneur.

So when should you become an entrepreneur.  Here are the kinds of questions you should ask yourself:

1. Do you have an idea that no one can talk you out of?  When you bounce your start-up idea off your spouse, friends and trusted advisors, are they able to raise enough objections that you begin to doubt whether the idea has merit.  Getting honest, objective advice can be hard because the people you are likely to go to care about you and may be afraid to tell you what they really think for fear of offending you.  Thus, you need to get feedback from objective parties (e.g., advisors, experts, prospective angel or VC investors with whom you don't have a deep personal relationship).
2. Do you have a partner you trust with complimentary skills?  Starting a company is a lonely adventure.  Having a partner that you can trust and whose skillset and experience is complementary to yours can be a huge functional and emotional benefit.
3. Are you prepared to endure with modest or no salary for a few years?  Founding a company often means making personal sacrifices and below-market cash compensation.  All the talk about "lean start-ups" (which I'm a big fan of) sometimes obscures the practical reality of what it means to eat through your personal savings. 
4. Are you bored with your current work environment/life situation?  There is nothing boring about being an entrepreneur.  More apt adjectves might include stimulating, engrossing, obsessive, exhilarating, nerve-racking - but not boring.  If you are tired of viewing your work as a chore and if every day is a bit of a grind, then entrepreneurship is for you.  I find that the intrinsic motivation behind an aspiring entrepreneur is sometimes the simplest - because it's fun.  Seeking fun can transcend all other factors. 
5. Do you perform best in the absence of structure?  In my book, Mastering the VC Game, I describe a metaphor for the three stages of a start-up:  the jungle, the dirt road and the highway.  In the earliest stages of a venture - the jungle - there are no clear paths available and the skills required are to thrive in the midst of the chaos.  For those who possess that makeup, being a start-up executive is an excellent fit.  But for those that like clear paths with little uncertainty and a great deal of structure - the highway - an early-stage venture will feel like a very uncomfortable environment.

Reflecting on these questions, I find it intriguing to reflect on what kind of environment - either from the perspective of parents raising their children or policy makers thinking about encouraging entrepreneurial ecosystems - can be created to foster more entrepreneurship?  HBS Professor Noam Wasserman is writing a book called Founding Dilemmas which is coming out later this year (I've read early drafts and believe it will be a must-read for entrepreneurs).  In it, he quotes career guru Dr. Tim Butler who points out that signals from parents, mentors and local leaders have a large influence on whether people chose to become entrepreneurs.   “We receive very powerful messages [from those around us] about what’s important, what success is, what failure is, what counts for achievement and what doesn’t. "

Celebrating entrepreneurial success stories in our culture and putting folks like Steve Jobs, Bill Gates, Larry Page (the new Google CEO!) and even more accessible, local heroes on magazine covers and in front of audiences is obviously a huge factor.  Every college kid in America looks at Mark Zuckerburg and thinks, "Why not me?"  Why not, indeed?

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Walking Away From Liquidity

With big tech companies awash in cash, nearly every analyst out there is predicting that the M&A market will heat up in 2011.  At a (pre-blizzard) conference I attended today run by Gridley & Co, this theme was reinforced, with rosy predictions of an M&A boom.

If this boom comes to pass, everyone will cheer.  Yet a strong M&A market won't be a panacea for all.  It will cause good companies to face perhaps the singular hardest decision in their lives:  whether to walk away from an opportunity for positive liquidity. 

Two of my companies have just gone through this process.  In each case, a strong unsolicited offer came in that would have yielded "VC-like" returns (5-10x) and many millions for the founders and senior executives.  But in both cases, everyone around the table unanimously, courageously (and hopefully not foolishly) voted to turn down the offers and walk away.  Having just lived through two of these episodes in the last few weeks, and having lived through many others in the past, I thought I'd share a few observations on this classic conundrum.

When to sell a company is one of the hardest decisions a board and entrepreneur face, and it's a decision made even more difficult if there is a lack of alignment around the table.  If different investors have invested at very different prices, or if the entrepreneur has not made money before and this is their first shot, there can be greater tension inserted into a naturally tense situation.  For example, if the Series A investor has a blended average post-money valuation of $20 million across three rounds, they may be happy with a $100 million exit.  But the Series C investor who just invested at an $80 million post-money valuation would be bitterly disappointed.  Meanwhile, the founder who owns 10% is looking at a $10 million payday - a heady sum for someone who still has a mortgage and is worried about saving enough money to pay for her kids to go to college.

It's all very theoretical, of course, until an actual offer is put on the table and everyone starts to calculate their share of the proceeds.  There is no easy answer to help determine which path to pursue, but here are five considerations that can help an entrepreneur frame the decision:

1. Passion. Do you still love running the business? Does it feel like you can’t imagine doing anything else with your life? Do you still feel like you have something to prove or do you feel tired and worn out?  Do the problems in the business energize you or drain you?
2. Belief.  Do you still believe in the business’s potential? Does it appear that the major proof points are still ahead of the company?  Do you feel as if the value will be meaningful greater after you have achieved a few more milestones - and that those milestones are well within reach?
3. Economics.  How much is the offer as compared to what it might be a year or two from now if the company were to successfully execute on its plan and hit its numbers? What might the company’s value be in a year or two if it falls short of its plan by 30 percent? How would you assess the probability of either path and then calculate the expected value of holding on for a few more years as compared to taking the money off the table by selling now?
4. Dilution Risk.  Does the business require more capital and, if so, can that additional capital be raised easily at a reasonable (and therefore not too dilutive) price?  What must the business be valued at after the additional capital to be equivalent to your dilution-adjusted payout today?  In other words, let's say you own 10% today and can sell for $100 million.  If your post-financing ownership will be 5%, then you are betting that you can sell for more than $200 million down the road.  Risk adjust this number and take into account the time value of money, and then assess the trade-off.
5. Team.  Do the people around you (i.e., your management team, your VCs, your family) want you to sell out or are they encouraging you to keep going?  When you look your team in the eye and tell them they are walking away from $x million each, do they stiffen their spines and project bravado - or do they look at you longingly, with regret?

It can be hard for VCs and entrepreneurs to be aligned in these situations, because the VCs have the luxury of a portfolio approach to investing in start-ups - they are looking for home runs that can move the needle on their funds.  Entrepreneurs, on the other hand, have no such luxury.  This may be their one shot to change their lives and their family's lives.  

I have found that the entrepreneurs who have made good, not great, money in the past are more likely to be both hungry and risk tolerant enough to go for the big win.  Having saved enough money to pay down their mortgages and pay for the kids' colleges, these entrepreneurs are willing to take more risk to make the kind of money that can really change their lives.  That sweet spot tends to be $2-5 million in liquidity.  More and more, I have seen investors show a willingness to allow partial liquidity for founders who have built enough value to raise money at high prices to soften the sting of walking away from an outright sale.

So the next time you hear about how robust the M&A market is going to be, remember that the real trick is for founders and boards to find that right balance between taking advantage of the robust market, and putting their collective heads down and focus on trying to build a big company. 

Top 5 Great Apps in 2010 - Great Companies in 2011?

Thinking back on 2010, the smash hit of the iPad and the continued proliferation of great iPhone and Android apps was one of the most striking aspects of the year.  As a user, I have fallen in love with five apps and find myself using them almost daily.  Millions of others are discovering these apps - and others like them.

But the gap between product success and business success is a large one.  There's an old saying in the venture capital business:  "Fund great companies, not great products or great features." The key question for 2011, therefore, is whether these great apps will mature into great companies.  Will they cross the chasm and move beyond the early adopter market into the mainstream market?  Will they build sustainable business models?  Twitter and Facebook were in a similar position a few years ago - great utilities that initially felt niche, and are now on their way to becoming great companies (OK, some of you will argue that Twitter still has a ways to go, but you have to admit, turning down $1 billion from Google in April 2009 is looking like a good decision in retrospect given the latest round of financing, led by Kleiner Perkins, at a $3.7 billion valuation).

So, here are my picks for the Top 5 Apps of 2010 that will face the challenge of becoming great companies in 2011:

1. Flipboard.  If you aren't addicted to the Flipboard app on the iPad, you can't consider yourself an information junkie.  Beautiful graphics and layout characterize this app, but what makes it brilliant in my opinion is they way it turns Twitter and Facebook into curated content channels.  I am naturally interested in reading the articles the editors of the New York Times and the Economist think I should read.  But I am also interested in reading the articles my friends are linking to in their tweets and posts - they are also relevant editors and curators for my interests.  The Flipboard business model is obviously still evolving and the leadership and backing of this company suggest they need to be taken seriously as a next generation content curation cum general information browser.
2. FourSquare.  I have long admired FourSquare and as part of my part-time duties at Harvard Business School, I decided to co-write a case on the company, which I will be teaching in a few months.  As part of this effort, I had the opportunity to interview the management team and learn more about the company's history and future plans.  The vision for the company is compelling and what appears in the application today is a fraction of the possible (Dennis Crowley observed that he has only implemented something like 20% of his 2004 NYU thesis on location-based services).  2011 will be a pivotal year for the company to turn some of their business model experiments into something scalable. 
3. Instapaper.  The only one on my top 5 list that isn't venture-backed (as far as I know), I love this app.  It allows users to bookmark things to be read later and then turns those links into an attractive content layout - in effect, your own newspaper.  The benefit is immediate and obvious.  The long-term business model isn't  immediate and obvious to me yet, but perhaps it will emerge in 2011.
4. TweetDeck.  I am totally addicted to TweetDeck.  This leading Twitter desktop and mobile app claims to have millions of subscribers.  When I am visiting start-ups, I often notice employees have three apps open and running at all times - Google Chrome, Facebook and TweetDeck.  I use TweetDeck to pull in my Facebook updates so I can keep track of my friends and those I follow on Twitter in one app.  Again, 2011 will be a critical year for them to begin to scale their business model.  Twitter hasn't yet tipped mainstream but is well on their way.  TweetDeck is following close behind.
5. Disqus.  Another quirky pick, perhaps, but I think Disqus is awesome as a blog response tool.  I use it for my own blog and I love when I see it on others' blogs as it makes it so easy for me to respond via email off my mobile device and track feedback.  I don't know how they make money and I presume they're still in lean start-up mode given how little they've raised (only $500k according to Crunchbase), but as a user I'm finding myself as dependent on Disqus as I am on my blogging platform.

So those are my picks for great apps in 2010.  What are yours?  Will any of them  become great companies in 2011?